Fitch: Lower Fuel, Steady Domestic Demand Support N.A. Airlines

NEW YORK--(BUSINESS WIRE)-- Credit profiles of North American airlines are expected to continue to improve in the near term as the current operating environment allows for improved free cash flow (FCF) and incremental opportunities to pay down debt, according to Fitch Ratings. North American airlines are reporting strong first quarter results, with higher operating margins reflecting the benefits of the recent decline in jet fuel prices and solid US domestic operations.

Fitch currently has Positive Outlooks on three out of eight publicly rated North American airlines (Southwest, United, and Delta). We upgraded three airlines in the first quarter of this year (JetBlue, United, and Air Canada upgraded to 'B+'). Further positive rating actions in the industry are likely in the near term, barring any unforeseen and severe macroeconomic or exogenous shocks.

Lower jet fuel costs are by far the biggest contributor to better first quarter earnings. Companies like American (no fuel hedges) and Alaska (uses only call options) experienced the greatest benefit in 1Q15 and are well positioned to take advantage of lower prices through the rest of the year. Other airlines that had out-of-the-money hedges experienced smaller benefits that nonetheless translated into significant cost savings. As fuel hedges that were entered into when crude oil prices were still high burn off through the course of the year, economic jet fuel prices for hedged airlines should continue to improve.

Thus far, domestic yields are holding up despite lower oil prices, meaning that fuel cost savings are translating into sizable improvement to net earnings and cash flow. We expect the cash generated in the near term to limit the amount incremental debt needed pay for aircraft and to fund other investments. Combined FCF for the four largest US carriers totaled $4.6 billion in the first quarter, some $3 billion higher than the same period last year. Strikingly positive results are notable given that the first quarter is typically seasonally weak for the industry.

Fitch notes that North American credit profiles were improving steadily even before the drop in jet fuel prices. An improved outlook for airline profits based on lower oil merely adds to the positive developments in the industry in recent years led by consolidation and capacity constraint.

Most North American airlines continue to emphasize their intentions to de-risk the business as a key priority for future cash flows, further supporting Fitch's positive industry outlook. Examples include United's decision to prepay $600 million of notes in the second quarter and Delta's $1.2 billion in contributions to its underfunded pension plan.

Cash is also likely to be increasingly directed towards dividends and share buybacks. Shareholder friendly actions could otherwise present a concern for an industry that has historically struggled to generate sufficient cash to fund its investments. However, Fitch does not view the current level of shareholder returns to be a material credit concern given the potential for the industry to generate significant amounts of free cash in the near term.

Fitch is cautious about the ongoing weakness in international markets. A strong U.S. dollar, increased competition from foreign carriers, and economic weakness particularly in markets like Brazil and Venezuela are expected to remain headwinds for international unit revenues. Concerns are partially offset by rational capacity actions by the major U.S. carriers. American, Delta, and United have all announced plans to decrease international capacity incrementally after the peak summer travel season.

Fitch also notes that the industry's improved levels of profitability in recent years will allow it to absorb some weakness in international markets without material impacts to carriers' credit profiles.

A key item to watch in international markets will be the growing dispute between North American network carriers and the three big Gulf carriers, Emirates, Etihad, and Qatar.

Unit revenues are also likely to experience pressure in some domestic markets due to added capacity. Markets like Seattle, with added capacity from Delta and Alaska, and Dallas with the recent capacity additions from Southwest are seeing heavy competition. However, our overall outlook for the US domestic market remains positive based on a steadily growing economy and modest aggregate capacity growth.

Additional information is available on www.fitchratings.com.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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Fitch Ratings
Joseph Rohlena, +1-312-368-3112
Director
U.S. Corporates
Fitch Ratings
70 W. Madison
Chicago IL, 60602
or
Craig D. Fraser, +1-212-908-0310
Managing Director
Corporates, Industrials
or
Kellie Geressy-Nilsen, +1-212-908-9123
Senior Director
FitchWire
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
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Media Relations, New York
Elizabeth Fogerty, +1-212-908-0526
[email protected]

Source: Fitch Ratings

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